An irrevocable trust that evolves with you

An irrevocable trust can be created to meet almost every goal -- whether it's to leave money to future generations in a way that ensures they won't squander it; bypass estate taxes on life insurance policies and other assets; make your wealth last through multiple generations; or protect yourself and your heirs from creditors.

Regardless of the purpose, all irrevocable trusts share some basic characteristics. Assets placed in the trust are owned by the trust, so they are generally safe from your creditors and no longer a part of your estate. That's where the estate tax savings come in to play: Since trust assets are outside of your estate, they're not subject to estate tax.

Beyond that, these trusts can help achieve personal goals for how you want your wealth to be distributed. The key is to choose the one that meets your specific needs while building in the maximum amount of flexibility allowed so that, as your needs change and evolve, you retain some power over the trust.

More On Estate Taxes:

"It's important to remember that when talking about irrevocable trusts, they are just that -- irrevocable," says Mike Cumming, leader of the tax practice group at Dykema law firm in Bloomfield Hills, Mich. Once the trust is created, it can't be revoked. While the creator of the trust no longer owns the trust assets, that doesn't mean he or she must give up all control. "We try to build in as much flexibility as possible without blowing the tax benefits" or the intentions for how the assets will be eventually distributed, he says.

Although irrevocable trusts are most often part of an overall tax-reduction plan, Cumming says, people with less than the current $5.25 million estate tax exemption amount typically create them with two other main goals in mind: asset protection and control over how the assets in the trust are used and distributed in the future.

One of the first important considerations when setting up a trust is its location, says John McManus, founder of McManus & Associates in New Providence, N.J. Some states offer better creditor protection, allow for a trust to exist for a longer period of years before becoming taxable or do not impose state income tax on trust assets. A few states, he says -- notably Alaska, Delaware, South Dakota and Nevada -- provide additional power to the trust creator while still protecting assets from creditors and maintaining the trust's tax-beneficial status. Although trusts can be set up in those states regardless of where you live, it is typically more expensive.

The trust as an equilateral triangle

When setting up a trust, the creator has control over the trust agreement, which is the legal document that determines the parameters of the trust. This is where to build in flexibility.

Cumming likens a trust structure to the three points of the triangle comprised of the trustee, the beneficiaries and the asset in the trust. "Each point can change. For example, sometimes the trustee will change as the situation changes, or beneficiaries will be added. The asset can change as well if the trustee has the power to sell some assets and reinvest."

At the top of the triangle is the trustee, the person who has legal title to the assets in the trust and the one responsible for managing the trust, making discretionary decisions and carrying out the terms of the trust agreement. The creator can be the trustee, but generally that's not a good idea in most states because, depending on how the trust is written, the state laws and how much discretionary power the creator has, the trust can lose its tax-beneficial status or be subject to creditors, McManus says.

Beneficiaries, the second point of the triangle, are those who will receive the beneficial interest in the trust. They can be amended, added or dropped if the creator of the trust retains the right of appointment, McManus says. "Let's say I have two layers of beneficiaries in my trust -- first to my wife and sister and then to my children and my sister's children," McManus says. "After I create the trust, I want to cut out one of the beneficiaries, or one of them needs more money. I have the right to choose who will receive money and how much," he says. Even better, he adds, "I don't have to decide that right away. That allows people to put a lot of assets in that trust when they otherwise might not because who knows how my sister's children will turn out or how my children will turn out?"

The third point of the triangle, the asset, can also be changed, if the trustee has the right to sell or invest assets.

Controlling distributions

Even though the creator of a trust can have some power over the appointment of trustees and beneficiaries as well as the management of the asset, a sticking point for many is the fear that beneficiaries will receive too much money or not enough to cover their needs.

The trust document should spell out when beneficiaries are to begin receiving distributions. The timeline can be governed by age of the recipients, a specific event or any other factor determined by the trust creator.

The amount of distribution is also up to the creator of the trust. It can be controlled by the use of ascertainable standards, which restrict the trustee to distributions for the benefit of health, education, maintenance and support, says McManus. These standards help ensure that the beneficiary's needs are met within reason and as defined by the trust agreement. They also protect the trust from being taxed if a child beneficiary is also named as trustee, McManus says.

"Usually the struggle for the trust creators is how they want to provide for the beneficiaries," says Cumming. "But from a tax aspect, you have to be careful not to give them too many rights to the trust, or it ends up being taxable to them."

When drafted properly, an irrevocable trust could not only save a bundle in estate taxes, but give you the comfort of knowing you've ensured a financial future for your beneficiaries.

Bankrate wants to hear from you and encourages thoughtful and constructive comments. We ask that you stay focused on the story topic, respect other people's opinions, and avoid profanity, offensive statements, illegal contents and advertisement posts. Comments are not reviewed before they are posted. Bankrate reserves the right (but is not obligated) to edit or delete your comments. Please avoid posting private or confidential information, and also keep in mind that anything you post may be disclosed, published, transmitted or reused. We do not permit the inclusion of hyperlinks in comments and may remove any comment that includes a hyperlink.

Bankrate.com is an independent, advertising-supported publisher and comparison service. Bankrate may be compensated in exchange for featured placement of certain sponsored products and services, or your clicking on certain links posted on this website.